Is there a wrong way to invest?

One of the fears that plagues beginners after taking a first look into most investment opportunities is the fear of doing something wrong. This is of course closely related to fears of losing money, making errors with taxes and other technical issues, but at heart, a large part of this fear can be attributed to the fear of making mistakes.

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What is the definition of  a mistake?

1. an error in action, calculation, opinion, or judgment caused by poor reasoning, carelessness, insufficient knowledge, etc.

If you look at the dictionary definition then you can clearly see what causes mistakes – lack of knowledge that leads to poor reasoning or leads to careless decisions. This means that mistakes are relatively easy to learn from – if you have done something wrong, then gaining extra knowledge is the way to make better decisions in the future.

The bigger problem is, how do you know that you have made a mistake? If you’re working on your portfolio, then no one will helpfully point out mistakes in your strategy, nor are bad returns a good indicator of having made mistakes since even perfect decisions can lead to temporary losses in bad market situations.

How do I know that I have made a mistake?

I get asked quite often to give my assessment of a person’s portfolio so they’d know if they’re doing the right thing. Other than the inherent problems that accompany such a broad question, assessing whether you’re doing something right is mostly based on one fundamental question:

How well is your portfolio doing compared to market averages?

If you are a real estate investor and your objects are returning an average of 3% per year then it’s likely that something might be problematic. Taking a look into overall investment returns for real estate you should probably assume a 5-7% return on lower risk projects and 9-12% for higher risk projects. If you’re not earning that then it’s time to look into your own portfolio – are the objects rented for under market price? Are your expenses too high? Is the location undesirable? Is the vacancy rate too high? Could you get better loan terms? Is the risk and returns level reasonably tied? If your object is super safe, has had the same renter for 6 years who hasn’t caused any issues, then 3% might even be an OK return when it comes to keeping property value.

If you are investing into crowdfunding based instruments then comparing yourself to market averages becomes more difficult. There isn’t really a set standard and a lot of comparisons are actually historically done compared to stock indexes. A good benchmark here might be the 11-12% generally used for SP500, if you have a more risky portfolio, then a higher target might be reasonable. Quite often people end up thinking their portfolio is underperforming because they have read from some forum that someone is making 30% returns on their social lending portfolio and are disappointed that they aren’t doing that well, without knowing anything about the truth of the issue or the risk profile of that person’s investment portfolio.

For a stock market based investor assessing returns is highly dependent on which part of the market cycle we’re at. If the global market is dropping, then your portfolio is likely to drop as well, and if you have stocks in your portfolio that make your portfolio allocation differ from indexes, for example you’re more focused on different industries, then it can become problematic to tell if you’re doing “well”. The same problem arises with a bear market, some stocks might be flying high, while your portfolio is slowly lagging behind, but you won’t be able to tell how big of an issue that is unless you balance your moderate turns to what are likely to be more moderate losses as well. Unless you’re using some very generic strategy, then it takes a full cycle to assess your returns, since then you will have lived through both a rise and a drop in the market.

Is it possible to avoid mistakes?

Let’s go with a resounding “no” on that question. We’re all only people, and making a perfect decision in all situations is virtually impossible. You will never have enough time, enough information and enough knowledge to make a fully informed decision. The more important issue is, to think about what the potential consequences of mistakes are.

When it comes to investing the cost is generally paid in effectiveness. If you make a bad call, then you will likely receive lower returns. If you make a fundamental error somewhere, then you will have to accept a loss of some size. This is where probability comes to play – if you constantly educate yourself, read up on what’s happening and don’t start testing out some obscure investment logics, then are you likely go make more reasonable decisions or more terrible decisions?

I’d say unless you are phenomenally unlucky at life, then you are likely to make more good decisions then bad ones, especially if you start reasonably conservatively (as in, not with high risk instruments like Forex, bitcoin etc.). While the loss in returns might be a hit (especially once you figure out what you managed to mess up), then even a low return of a couple of per cent is always better than no returns since you didn’t gather up the courage to do anything.

4 thoughts on “Is there a wrong way to invest?

  1. I disagree with the fact that 3 % yield is okay for a good tenant.
    However, probably the rent yield is 3 % but then the value growth of the property should compensate the low rental income.
    In Helsinki you get something like 3-5 % rental yield + another 3-5% price growth.
    In Tallinn you probably get 10 % rental yield + 3-5 % price growth.
    Also, the advantage of real estate investing is the fact that while your loans get ammortized, your rent gets increased. That’s pretty sweet in the long run (5+ years).
    Personally I am going to close a real estate deal on coming Thursday with cold hard cash, and I negotiated on Friday 60 000 euros loan for my next project with 100 % financing. My goal is to buy a whole house in the coming months with that 60 000 euros (it will result my real estate portfolio to 126 000 euros). That ~ 60 000 euro’s house should bring annual net cash flow before taxes 7000-8000 euros/year.

    For you also I would encourage you to reserve an appointment with your bankster and negotiate a loan for your next real estate deal. The interest rates are now so low that it is a shame if You do not benefit from it. :)
    If you are a daredevil, you can for instance take a second mortgage of your own home (assuming you have some free equity there) – and of course as a permission of your husband also. 😀
    The low interest rates are there for giving incentives for investments, therefore it is something one should do now in an aggressive manner. When the interest rates start rising, then I would advice to slow down and let the loans be ammortized.
    I am pretty sure the bankster will be pleased to lend you money… But be sure to prepare for the appointment with appropriate calculations with “worst case scenario”.

  2. Again there’s not much to add to yet a solid Kristi-article. Making mistakes is part of live and investing is not different. I for one have done tons of investing mistakes but fortunately there have been some successes and the net result is not spectacular but at least decent. Ideally one should learn from mistakes done and gradually become a more skilled investor. To some extent that is true but even today after decades of experience I make bad/unfortunate decisions occasionally. So in my case obviously practice doesn’t make perfect 😮 Still I think it’s a good thing to invest and I recommend people to try to improve their lot through investing. Don’t worry too much over lacking experience. Follow that sportswear company’s advice: “Just do it”. But start in small scale and practice a little before investing real money. That’s the way most of us have to do anyway. Normal people start with small incomes so there’s not much choice 😀

    1. Yup.
      Generally, before you invest you need to carefully study the strategy you are using (like in p2p lending your strategy might be as follows: invest only into prime borrowers 10 e/each and expect to get 5-10 % pa after taxes). And let the loans ammortize in your portfolio slowly (“exit” of each loan is automatic in this).

      Or in real estates: buy as many appartments with rental yield of 10 % or more and try to accumulate as much loans as possible for it when interest rates are low, hedge against the rise of interest rates, ammortize as slowly as possible in order to maintain a good
      amount of leverage as possible, be picky with tenants and enjoy the results.
      Exit strategy in larger real estate portfolios is a harder nut to bite… Probably setting up some kind of REIT and then list it into stock exchange is a possible strategy for exits… Or set up a company around them, and then sell it to even bigger player.

      Or in stocks: buy when everbody sells and sell when everybody buys.

  3. The main wrong way to invest is not to invest. What I mean is that even in the case where you invest extremely poorly and lose money, in most cases the person is still better off than otherwise would’ve been by using that money for consumption instead.

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